Despite an excellent full-year result, the Azure (AZV) share price closed down 6% after its release on Thursday.
The result was above my expectations, with revenue up 40% to $31.3 million and net profit after tax (NPAT) up nearly 300% to $3.85 million. This compared to my forecasts of $28.1 million revenue and $3.7 million NPAT.
Maybe the market was disappointed with the lower second half in comparison with the first half. Or maybe it was due to the operating cash flow being well below the reported profit. If it was to do with either of these factors, then the sell-down was not justified in my view.
At the first-half result management clearly stated that there was a seasonal weighting towards the first half. The operational cash flow discrepancy is also easily explained. Large contracts towards the end of the financial year meant there was a working capital drag of approximately $2.45 million. There was also $0.7 million of goods that were pre-ordered for work that will be completed in FY15.
Normally with small caps the trick is to find out the hidden traps, and what has been overstated in the accounts. The combination of MD Robert Grey and CFO Jason Darcy provides the exact opposite. The deeper you look into the result, the better it gets. For one, just about all costs are expensed, even though many could have been capitalised on the balance sheet. There was $2.6 million of R D costs, and one-off costs to set up the US factory of $0.59 million. Another $0.25 million was expensed for compliance expenses including FDA registration.
There was a $0.526 million tax gain due to a refund on some of the R D spend. This is a tax ruling for up to $20 million of revenue, when a company has accumulated losses.
Netting all this out, the $3.85 million NPAT is understated, and consequently a higher price-earnings ratio (PE) is justified.
At $0.37 the stock is trading on a FY14 PE of 18. As well as the conservative accounting, the expected high growth rates justify the PE premium to the market. According to Grey, revenues in the US can double each year for the next 4-5 years.
In FY14, revenue in the US was $6.1 million, or 19.5% of the group revenues. For FY15 if we leave all non-US regions the same and the US doubles, then that gives $37.4 million of revenues or another 20% gain on group revenues. With the higher proportion of software sales, margins will also continue to increase. I am forecasting 25% group revenue growth for FY15, with upside risk similar to this year. FY15 NPAT is forecast to be $5.2 million, placing the company on a forward PE of 13.
Due to the company’s reputation for delivering on quality solutions, its customer retention rate is high. This customer base now includes over 8,500 sites globally, remembering Azure started as a pure nurse call system hardware provider, and is now providing the combined hardware/software offering to its existing and new customer base.
The company will look to leverage this customer base further by seeking to acquire complementary businesses. It most likely would involve an expansion on its clinical workflow capabilities.
Azure has about 50% market share in the Australian aged care nurse call market, and 35% of the acute hospital market. With 3% of the global share, Azure is the largest player in the market outside of North America. In the US, it is chasing down the market leader Royland – recently winning contracts over them both in the US and outside. Royland is around three times larger than Azure, with revenues of approximately $100 million.
The company has not named who the mystery bidder was in April this year. As explained at the time, if the bidder was Australian based it may have been difficult for them to offer a large enough premium to the market price at the time. The reason for this is Azure’s largest share price driver is US-based growth, and a domestically-focused company may not see the same value in that.
After acquiring two of Azure’s domestic-based competitors, Hills Holdings (HIL) is now the largest Australian competitor. Hills also reported its full-year result last week. It appeared to be mixed and it was difficult to determine the underlying profit, with a number of one-offs, acquisitions, asset sales and write-downs. It was interesting to see it has already written down the asset value of its Questek acquisition despite only acquiring it earlier this year – Questek is a smaller version of Azure.
Rolling forward our discounted cash-flow valuation, and with slightly increased long-term forecasts, our $0.39 Azure valuation increases to $0.46.
At the time of publishing AZV was trading at $0.45 vs our target price of $0.46 and, as a result, we are downgrading our recommendation to Hold. We remain very positive on the company's long-term prospects and the company could easily exceed our earnings forecasts.
To see Azure's Forecasts and Financial Summary, click here.